Sympathies and Loss Aversion

Daniel Hamermesh suggests on Freakonomics that our aversion to losses is so strong that we feel it… even when the losses accrue to others.

I am sympathetic; and I, and other taxpayers, am being asked to provide relief in one form or another. People who bought houses whose basic value far exceeded what they might reasonably have expected are now expecting other taxpayers to bail them out; and the expectations will probably be satisfied.

But what if one poses the issue in reverse: Would taxpayers be willing to put tax dollars into a program that would buy single-family houses that are larger and more valuable than would be consistent with usual standards of prudence in mortgage lending? I strongly doubt it.

Hamermesh calls this “second-hand endowment effect.” (The endowment effect occurs when we have an innate liking of the things we already own; it’s closely related to loss aversion.)

It’s quite interesting to gauge one’s own reactions to these two mathematically equivalent scenarios; it gives a visceral sense of the power of loss aversion as a fundamental principle of behavioral economics.